Welcome to the new Becker-Posner Blog, maintained by the University of Chicago Law School.

January 2010

01/31/2010

President Obama, in his State of the Union Address last
week, indicated that he would assist small business, particularly to encourage
their hiring of additional workers. Two days later he proposed a $33 billion
tax credit to small businesses that increase their hiring. I consider small and
medium size business the backbone of any dynamic economy, so I sympathize with
the President’s desire to encourage these businesses. However, his proposal is
not a good way to do this.

Obama’s aims are laudable: to
simultaneously increase employment, reduce unemployment, and encourage the
expansion of small and medium sized businesses. Yet, as an
employment-increasing plan, the President’s approach has many problems, and is
likely to have only limited impact. This is partly because while $33 billion is
a lot of money, it is less than ¼ of one percent of American GDP. Yet even a
much larger sum would have a small impact on employment. One reason is that the
subsidy proposal gives small business some incentive to fire some employees,
and then later to replace them with unemployed workers for whom they can
collect the subsidy.

The unemployed hired under
the subsidy program would likely receive higher pay than they would get
otherwise because companies compete for these workers to qualify for the
subsidy. Some workers might then remain unemployed rather than accept jobs in
order to get the higher pay after the program is implemented. Employed workers
at small (and even large) businesses might quite their jobs and become
unemployed in order to become subsequently employed at other small companies in
order to become eligible for any higher wages received by new hires. The
President is aware that efforts will be made to game the proposal, and he
proposed various safeguards. However, new ways will be discovered to
get around the restrictions that would reduce the net job creating potential. Further efforts to close loopholes
would lead the government to become more and more involved in the employment
decisions of companies.

Smaller businesses are an
important source of innovation and progress. Businesses like Microsoft,
Wal-Mart, Apple, Google, and many others introduced game-changing innovations
when they were very small that enabled them to grow very large, and they raised
overall productivity. This is why it is so important to promote startups and
other smaller businesses in an efficient and effective way. An effective
approach has several components, and overall the US looks quite good compared
to other countries. According to World Bank estimates, the US ranks 8th
out of the more than 180 countries they consider on their overall index of the
ease of starting a business, whereas, for example, Italy ranks 78th,
and China 89th. On the other hand, the US ranks only 25th
on the ease of getting construction permits, and 61st on taxes.

The US is tied for first
place on the ease of employing workers. It is much easier for American small
and medium size business to reduce their employment during bad times than it is
for similar-sized companies in Europe, Latin America, or India. This helps
explain why employment fell, and unemployment rose, more sharply during this
recent recession in the US than in say Germany, Italy, and many other countries
that have much less flexible labor markets, even when other countries
experienced larger recession-induced falls in GDP.

Unfortunately, several
proposals in Congress, and others mentioned by the President, would make it
less attractive to start a business, or expand a smaller business. Although it
is especially unclear after the election of a Republican senator from
Massachusetts what any final health care bill will contain, some of the
proposals would require all companies, with few exceptions, to provide health
insurance for their employees. The fact that many small businesses do not now
give their employees health insurance indicates that such a requirement would
raise their costs, and reduce their employment.

Small and medium sized
business owners are sensitive to capital gains taxes, increased taxes on larger
incomes, and high rates of taxation on estates. Yet leading members
of Congress have advocated increases in capital gains taxes, adding an
additional tax on ”high” incomes, and a return to higher estate taxes. These
proposals would hurt all higher income persons, but might be particularly
discouraging to startups,and to the expansion of smaller businesses.

I believe that smaller
businesses can competes effectively against more sluggish larger and more
established businesses without getting special privileges, such as the
President’s additional proposal to subsidize bank loans to small businesses. However,
small business does thrive much better in an environment where success is not
taxed at high rates, and where regulations and mandates do not have a
disproportionately large effect on their costs and profits.

The President is asking Congress to enact a one-year $33 billion job-subsidy plan. An employer would receive a $5,000 tax credit in 2010 credit for increasing his labor force by one person and an additional subsidy for giving an employee a wage increase greater than the inflation rate. The total subsidy would be limited to $500,000 per employer, in the hope that the principal recipients would be small businesses. I do not know why the ceiling should be expected to have that effect. Even big businesses like $500,000 windfalls. If a big business happens to be increasing its hiring or its wages, why wouldn’t it claim the subsidy?

That point to one side, and disregarding also the abundant possibilities of gaming the program, stressed by Becker, the proposal is unlikely to be effective because it violates the economic principles that ought to guide stimulus programs.

The theory of stimulus is Keynes’s, is (in my opinion) sound, and is as follows. If, because a high rate of unemployment creates pessimism about the economic situation, people increase their savings at the same time that business is reducing its investing—and that is our situation today—the government can by financing projects through borrowing put the inert savings to work (inert because businesses aren’t borrowing people’s savings). The projects require workers, so unemployment falls, and with it pessimism and the cash hoarding, by consumers and businesses alike, that pessimism induces.

With Keynes’s theory understood, it becomes possible to list the principles of effective stimulus:

The stimulus must be large in order to make a substantial dent in unemployment. The $787 billion stimulus enacted last February may have been too small; a $33 billion jobs subsidy is a drop in the bucket.

The stimulus must be implemented before recovery from a depression or recession is well under way—otherwise the government’s borrowing to finance the stimulus will slow the recovery by pushing up interest rates. (That is, at some point in the recovery, business will resume investing and so will be competing with the government for capital.) If enactment of the job subsidy is delayed in Congress, or if procedures for preventing the gaming of the program are cumbersome, the subsidy expenditures may come too late to do any good.

The stimulus must be targeted on industries, and areas of the country, in which unemployment is high. Like the $787 billion stimulus, the job-subsidy plan flunks this test as well.

Most important, a stimulus is designed to stimulate demand, not supply. The economic problem for which a stimulus program is a solution is insufficient demand relative to the economy’s labor and other resources. Because of overindebtedness and continued weaknesses in the financial system, consumers and businesses are reluctant to spend. Businesses are reluctant to hire (that is one aspect of their reluctance to spend), so unemployment is high and wages are stagnant, which further depresses demand. The idea behind the stimulus is for government demand to take the place of the missing private demand. Government “buys” new roads, in lieu of consumers’ buying SUVs, and contractors meet the government’s demand by hiring unemployed construction workers. The job-subsidy plan is not demand-focused, and so is unlikely to contribute to the economic recovery. Suppose a firm in a depressed economy sells 100 earth-moving machines a year, and employs 200 workers. If the government tells the firm it can save $5,000 on its taxes by increasing its work force to 201, the firm’s total costs will increase (by the wages and benefits of the additional worker less $5,000), but its revenues will not increase because adding a worker does not increase the demand for its product.

There is an enormous amount of idle productive capacity in the U.S. economy at present. There is thus a case, as liberal economists such as Paul Krugman keep urging, for further stimulus spending. The problem is that such spending is irresponsible unless coupled with a credible commitment to repay, after the economy recovers, the money borrowed to finance the spending. Not only is there no such commitment; at present the only realistic prospect is of staggering deficits stretching indefinitely into the future. As a result there is at present no stomach for additional stimulus spending. The government is reduced to impotent gestures, of which the job-subsidy plan is one.

01/28/2010

In the wake of the attempted Christmas bombing of an American airliner en route to Detroit, there has been a flurry of new security measures. These measures are costly, primarily in delaying the passage of passengers through airport security, but there are also the expenses of additional screening equipment, such as body scanners, and of additional security personnel, such as armed guards on flights and additional screeners in the intelligence agencies.

The economic question is the optimal expenditure on preventing terrorist attacks on airlines. The question is bafflingly difficult because of the uncertainty associated with such attacks. Cost-benefit analysis of precautions is a reliable tool of economic decision making only (in general—I will suggest an exception below) when not only the cost of the precautions and the loss (cost) that will occur if the event sought to be prevented is allowed to happen can be calculated, but also the probability of the event if the precautions are not taken. For that second calculation is also necessary in order to estimate the expected loss if the precautions are not taken. If the loss if the event occurs is $x, and the probability that the event will occur unless precautions are taken to prevent it is .01, then, as a first approximation, one should spend up to $.01x to prevent the event from occurring, but not more.

But what is the incremental probability of a successful terrorist attack on an airline if the precautions instituted after the Christmas bombing attempt are withdrawn? Moreover, although that is the most difficult question, there is also uncertainty about the loss should such an attempt succeed. There are pretty good value of life estimates, which would suggest for example that an airline bombing that killed 200 people would inflict a loss of $1.4 billion (200 x $7 million). But that leaves out the terrible fear that these people would experience unless the bombing caused instant death (which it would not), plus the fear of other airline passengers and crew after the bombing, plus added time and safety costs of passengers diverted by fear to other means of transportation—other means that may be more serious, depending on how common successful terrorist attacks on aircraft become; for the death rate per mile is, at present anyway, markedly higher for automobile transportation than for air transportation. There is an instinctual fear of flying (easy to explain in terms of the ancestral environment in which the human brain developed, for in that environment heights were exceptionally dangerous), and as a result the prospect of being killed in an airline crash fills many people with particular dread; that prospect is a cost, like any other. For many people, it exceeds the expected accident cost of driving relative to flying.

But I want to focus on the uncertainty of the occurrence of a terrorist attack. Some statisticians, and some famous economists of yore such as Frank Knight and John Maynard Keynes, distinguish between calculable risk, as in my .01 example, and uncertainty, in the sense of risk that cannot be calculated with any confidence. No one can say with any real confidence what the probability of a successful attack in the next year on a U.S. airline (specifically on a flight originating outside the United States, which seems the likeliest type of terrorist attack) is, except that it is between 0 and 1, which is unhelpful. (It is naïve to base an estimate of probability on frequency, that is, on past occurrences, if there is no reason to believe that the future will be like the past.) In fact not only most travelers but also the airlines and the government think that the probability of a successful airline attack is much closer to 0 than to 1; if they thought it was close to 1, there would be far more radical precautionary measures taken and a sharp decline in demand for air travel.

But it makes a big difference to the optimal investment in precaution whether the probability of such an attack is .0001 or .1 (as it could easily be if the attack was the first in a planned series), and whether the cost of the attack if it is successful would be $1.4 billion or $5 billion--or much more, as it could be, if one thinks that the Iraq and Afghanistan wars, which together have already cost at least $1 trillion, were a consequence of the 9/11 terrorist attacks. There is thus uncertainty in size of loss as well as in probability of loss. As a result of these dual uncertainties, the realistic expected-loss range could, on my assumptions, easily extend from $140,000 to $500 million.

How to pick a point in that range? The question may seem unanswerable, but it is not. The reason is discontinuity in the range of available precautions. Greater vigilance and more screening equipment and screeners are costly but there are sharply declining marginal returns. One might decide to place two or three guards on every international flight, but it wouldn’t make any sense to place 10 guards on every flight; the incremental benefit would be negligible. Similarly, maybe every security line in every international airport should be equipped with a body scanner, but it wouldn’t make sense to equip every security line with two body scanners. The inability of our intelligence agencies to pool information effectively will be costly to correct, but these are costs that have to be incurred anyway—to protect the nation from a range of terrorist and other threats, not just threats to airline safety.

There is probably a bias among security personnel in favor of doing more than can be justified by the kind of analysis that I have just offered: that is, a bias in favor of adopting some precautions that have little or even no efficacy in preventing attacks, such as subjecting children who have already been patted down in the security line to a second pat-down at the airline gate. The reason for the bias is bureaucratic, or in other words careerist: from the career perspective of a security officer, the worst thing that can happen is an exact repetition of a successful attack. For then no excuses, even if reasonable, for having failed to prevent the new attack will be accepted. So security agencies will tend to overinvest in preventing the repetition of previous attacks. It has been argued persuasively that the nation has overinvested in airline security since 9/11 relative to security against other attacks, for example on trains or subways, because we have thus far been spared such attacks, though other nations, notably Britain and Spain, have not been.

The purpose of terrorism, wherever it occurs, is to create
fear that is disproportionate to the size of any terrorist risk. As Posner
indicates, many people have considerable fear of flying even under the best of
circumstances. This fear is increased when there is an attempt by a suicide
bomber to blow up a plane, as happened in December on a Northwest flight going
from Amsterdam to Detroit. The fear is multiplied several fold when attacks are
successful. Air travel within the US, and between other countries and the US,
took a nosedive after the 9/11, 2001 successful multiple attacks on planes
going to New York and Washington.

Yona Rubenstein of Brown University and I have studied in
detail reactions to the terrorist attacks on Israeli buses and restaurants
during the Intifada period. We show that bus travel in Israel fell
significantly after every suicide attack on a bus, while the use of taxes and
private cars increased. Similarly, eating in restaurants fell rather sharply
after a suicide attack at a restaurant, and this was partially replaced by take
out orders. To attract business, restaurants began hiring private guards
stationed in front of restaurants, and these guards thwarted several attempted
suicide bombings.

Airlines have to give a similar reassurance to air travelers
by providing a level of security that allays many of their often magnified fears. The optimal level of security on air travel is much higher
than would be the case if an exaggerated fear of air travel due to
possible terrorism were not so prevalent. For this reason, checking of shoes,
laptops, liquids, and even body scanners may be often useful, even when they
are not so effective.

In addition, greater profiling of passengers would be
desirable. After the December bombing attempt, President Obama did order a more
careful check of individuals coming from higher risk countries, such as Yemen.
That is a step in the right direction, but it is not enough. Young males of
Moslem background have committed virtually all the terrorist attacks against
airplanes traveling to, or within, the US. They should have the most invasive
security checks. Since it is not always apparent who is a Moslem, this
profiling would often have to be proxied by country of origin, name, and other
such identifying features. Many law-abiding young Moslem males would be
offended by having to go through an especially intensive security check, so
they should be treated with the utmost respect. It might also be publicized
that such intensive procedures would make it easier for young Moslem males to
get American visas.

Terrorist organizations would react to such profiling of Moslem males by trying to find substitutes. Perhaps the closest
substitutes are religious young Moslem females, and young non-Moslem males who
are sympathetic to the terrorist cause. Therefore, these groups should face
tougher security checks than other passengers, but not as tough as young Moslem
males. Probably the optimal approach would be to inspect a fraction of members of
these groups as carefully as young Moslem males, while the other members would
be given a less complete check. Other passengers, such as old women and men,
and young children, do not need to receive onerous checks. Since the vast
majority of passengers fall into low risk categories, extensive profiling of
the high security risks would reduce the overall security effort while at the
same time increasing the protection of air travelers from terrorist attacks.

I recognize that explicit profiling is unpopular in some
quarters, in part because the profiling of African Americans with regard to
crime detection and prevention was abused. Nevertheless, making judgments about
the likelihood of different tendencies in various groups is an inevitable part
of personal as well as business decision-making. For example, advertisers know
that men are more likely to watch sporting events than women, and film
producers know that women are more likely to watch love stories, and men are
more attracted to pornographic films.

Vigilance is needed to make sure that profiling of
passengers is not abused, and that it is conducted politely.Yet it is unwise to give in to political correctness, and
require all passengers to go through the inconvenience and loss of time
involved in extensive airport security checks, when only a very small fraction
of passengers pose a terrorist threat.

01/17/2010

Invention of the telegraph and telephone in the nineteenth
century had revolutionary impacts on the speed of communications among
individuals separated sometimes by vast distances. The Internet and wireless transmission
has not only vastly extended the ease of communicating quickly, but also
provides quick access to information on a scale far surpassing anything
available before.

“Googling” is a new word not only in English but in many
other languages as well that means using Internet search engines to discover
information on an endless number of subjects. These include finding
the cheapest online price for tennis rackets, cars, hotels, and many other
goods and services, finding a time series on GDP per capita for the United
States, China, and other countries, discovering when a famous phrase was first
used, finding out what is contained in the House of Representatives’ and the
Senate’s versions of the health “reform” bills, reading criticisms of government
policies, getting email addresses for particular individuals, and tens of
thousands of other purposes. I would find it virtually impossible to fit
posting on our blog into a busy teaching, research, and speaking schedule
without quick access through the Internet to generally reliable information.

Although newspapers have frequently been subject to various
forms of censorship, Internet access is affected by hackers as well as by
censors. We were forced to change our website address and the technical manager
of this blog because the old website was hacked so much that posting of
commentary became impossible (we do not know who was doing this). Of course,
various governments try to deny their citizens access to websites that they
consider too critical of government policies. A few weeks ago I received an
email from someone in China complaining that he and his friends no longer could
access our website because it was being blocked by the government. I was
surprised by the claim, and yet a little flattered that we were considered
important enough to be blocked. I suggested he try our new website address, and
he discovered it was available with no problems. Access was prevented by
hackers on our old website rather than by the government.

Google recently complained about Chinese censorship, and
claimed that hackers from China gained access to gmail accounts of some persons
critical of government policies. As a result, Google threatened to shut down
its Chinese website. It is difficult to determine when the censorship goes so
far that the benefits of making the Google search engine (or other online
facilities) available to the Chinese population is no longer worth accepting
the censorship. My own view is that censorship has to be very extensive and
destructive before the benefits of withdrawing Google exceed the costs to the
population of losing access to an important information search engine.

This weighing of benefits and costs is especially pertinent
since many Chinese Internet users, and presumably also those in other countries
with extensive censorship of the Internet, have learned how to “scale the
wall”. That is, they discovered ways to get around Internet restrictions by
using proxies, virtual private networks, and other tools that allow computers
to access the Internet through remote servers located outside China.

The strong efforts of some countries to try to block
Internet access to articles and discussions that their governments do not want
their citizens to see indicates the scope of the knowledge and information the
Internet makes available that was unavailable in the past. This leads me to
conclude that generally Google and other companies experiencing censorship
should stick it out. However, perhaps they should fund research on finding
additional ways to “scale the wall”.

During this financial crisis, various financial markets have
been criticized, some of them justifiably, as being much less efficient than
had been claimed. Nevertheless, search engines, social networks over the
Internet, like Face Book and Twitter, apps, and other electronic forms of
communication, have greatly improved the efficiency of many markets, including
financial markets. For example, the open outcry system on stock and futures
exchanges to buy and sell securities, like the New York Stock Exchange or the
Chicago Mercantile Exchange (CME), was made obsolete by much faster and more
efficient electronic communication (see Leo Melamed’s book, “For
Crying Out Loud” for a fascinating discussion of the battles to get the CME to
go electronic). Retail and other companies continue to expand their online
presence and websites in recognition of the growing share of their business and
sales that is conducted online. Persons in small towns with only a few stores
often now have access to the same variety of goods and to the price competition
that used to be available only to residents of large cities, where many stores
competed for their business.

Many persons lament the decline of newspapers and magazines
due to the migration of help wanted ads and other advertisements to the
Internet. Some politicians and public intellectuals have even proposed greater
subsidies to newspapers in order to slow down their decline. Clearly, top
papers like the New York Times, Wall Street Journal, Financial Times, and
Washington Post often have in depth reporting on various subjects seldom found
on television or radio. However, the Internet has a greater variety of news
presentations and articles on specialized subjects, and much more up to date reporting,
than is available even in the best newspapers. The Internet has been remarkable
in being able to tap into the desire of people from all walks of life to write,
through blogs, social networks, and other ways. Hundreds of economists have blogs,
although many are not very good, and the same is true for other fields. Some blogs
compile the scholarly citations of other individuals who are blogging, in order
to give readers at least one measure of their authority and reliability.

I am old fashioned enough to read three newspapers in hard
copy each day, but the overwhelming majority of young people seldom read any
major newspapers. This difference between the young and old in their reading
habits predicts a continuing further decline in newspaper circulation, and a
further migration of news reporting and opinion pieces to the Internet. On the
whole, this is a good development from the point of view of increasing
competition among news and opinion sources, although it is sad to see the
decline of an industry that has been so crucial historically in providing
information and preserving political freedoms.

I agree with Becker that the Internet has been on the whole a valuable innovation. It is a less costly form of communication than either telephone or mail, and (a related point) a better substitute for personal communication than either telephone or mail; it economizes on time by reducing the transportation involved in meetings. I commute to work less frequently nowadays because I can work efficiently at home; and academics in different universities or even different countries can collaborate in writing books and articles at far lower cost than if they had to rely on the older modes of interaction. The Internet also, as Becker emphasizes, reduces the cost of access to information (though not always accurate information); it thus reduces information costs as well as communication costs.

As with most new technologies, however, there are downsides as well as upsides. The effect on substitute services as such should not be cause for concern except to the producers, for substitution effects are the inevitable consequence of innovation. The hotel and travel industries are hurt if business travel falls because of the substitution of online for in-person conferencing, though the hurt is offset to the extent that by lowering the costs of communication the Internet increases the amount of business activity and the geographical scope of firms.

But other harms caused by the Internet warrant social concern. The Internet lowers the cost of communication and there are bad as well as good communications: bad in the sense that they promote activities that reduce overall welfare. Examples are the use of the Internet by terrorists, by advocates of hate crimes, by purveyors of child pornography, by plagiarists, by defrauders, by violators of copyright law, and by identity thieves. The increase in these pathologies as a result of the Internet is a social cost and may be considerable. The contribution that the Internet has made to the recruitment and coordination of terrorists has created a considerable threat to our national security.

Of course, it is possible to monitor Internet communications, and our security and law enforcement agencies do that. But the volume is overwhelming; coded communications provide a challenge to monitors; and privacy advocates insist on limitations on monitoring.

The Internet is also highly vulnerable to penetration and disruption by enemies of the United States.

China and other authoritarian countries censor the Internet to prevent their populations from obtaining access to information critical of government. I agree with Becker that we should not make efforts to prevent China from censoring the Internet. I don’t think we should interfere in the internal affairs of countries that are not enemies of the United States. I also don’t think that Chinese censorship will be effective in the long run; it is too easy to circumvent Internet censorship.

The negative impact of the Internet on the newspaper industry is a possible source of concern. Newspapers are a bundled product: the publisher provides a large variety of news, opinion, and advertising in an effort to obtain a large enough readership to offset the heavy fixed costs of producing information. The Internet enables unbundling at low cost, which makes it difficult to cover those heavy fixed costs. As classified advertising migrates from newspapers to inexpensive Internet services, for example, the revenues of such advertisng no longer support costly newspaper newsrooms. But the effect on the extent to which the public is well informed may be offset by the rise of the blogs, which provide immense quantities of information and opinion on public issues at zero cost (other than time cost) to readers. At the same time, however, because the blogs are an unfiltered medium they are also a source of a great deal of misinformation. Yet Wikipedia illustrates how prompt correction, which the Internet also facilitates, can reduce inaccuracies in online dissemination of information.

The time costs imposed by the Internet are a source of some concern. People receive a great many more communications, because of their lower cost, in the form of email than they did in letters and phone calls, because email is cheaper. This can be a burden, and it is only partially offset by the “junk mail” filter programs that email services provide. The sender of a communication will usually not consider the cost to the recipient. Information overload can be a real cost.

Finally, we have become aware recently than the use of the Internet by drivers is a significant source of automobile accidents.

The net effect of the Internet on social welfare has probably been positive, but it is difficult to say how great it has been. Communication and information flows were rapid before the Internet, and the effect of increased rapidity on economic output and personal satisfaction may not be great when the full costs of the Internet are taken into account.

01/10/2010

On December 14, Becker and I blogged about the shortcomings ofGDP (Gross Domestic Product) as a welfare measure. A related question is the relation between GDP or other measures of economic prosperity and happiness, or what utilitarians and welfare economists refer to as “utility.” The great utilitarian philosopher Jeremy Bentham defined utility as the excess of pleasure over pain, or equivalently (for he did not confine pleasure and pain to purely physical sensations) happiness.

Most people, including most economists, do not regard per capita income or other measures of economic welfare (such as GDP, which is the market value of all goods and services sold in the United States, whether for consumption or investment, in the course of one year) as an end in itself, but as a contributor to human happiness broadly conceived. They expect the contribution to be positive, however. Most people devote much of their time to trying to increase their income, which suggests that income and welfare are positively correlated. I will question this expectation and this suggestion.

The United States has the highest per capita income of any large country, and so one might expect it to have the highest per capita happiness. But surveys indicate that this is not true; in one well-known study (http://en.wikipedia.org/wiki/Satisfaction_with_Life_Index#International_Rankings_2006) (visited Jan. 9, 2010), for example, the United States ranked 23rd out of 178 countries. Denmark was first, Burundi last; nevertheless there was a general though rough correlation between happiness and per capita income: the happiest countries are rich, the unhappiest poor. And generally as countries become richer, their inhabitants become happier. These correlations are confirmed in an important and careful study by the economists Betsey Stevenson and Justin Wolfers, available at http://bpp.wharton.upenn.edu/betseys/papers/happiness.pdf (visited Jan. 10, 2010).

Cross-national comparisons are of limited significance because other things affect happiness besides income, such as health, population density, religious beliefs, quality of public services, internal and external security, family structure, climate, and income equality (given declining marginal utility of income, the more equal incomes are—holding other things constant, an essential qualification, obviously—the higher average utility can be expected to be). Thus the fact that the United States ranks only 23rd in happiness is not terribly meaningful.

However, an important finding in another article by Stevenson and Wolfers, “The Decline of Female Happiness,” available at http://bpp.wharton.upenn.edu/betseys/papers/Paradox%20of%20declining%20female%20happiness.pdf (visited Jan. 9, 2010), is that in the United States men’s happiness is essentially unchanged since 1970, and women’s happiness has declined significantly, so that average U.S. happiness has declined. In 1970, the average woman was happier than the average man; today the reverse is true. In most other developed countries, average male and female happiness has grown, but male happiness has grown relative to female happiness.

The authors adjust for compositional effects in the United States—such as changes in the racial and ethnic composition of the society, labor force participation, education, marriage and divorce, and age—and, surprisingly, find few differences. (One difference is that blacks, especially but not only black women, are happier today than in 1970.) They speculate (plausibly, in my opinion) that because women are on average more risk-averse than men, they find the range of career and relationship choices open to women nowadays a source of unhappiness. The United States has become more competitive in the last 40 years, and relatively to most other developed countries as well, and this may explain the different overall happiness trends, though it does not explain why male happiness in the United States has not declined.

Probably the most notable finding in the Stevenson-Wolfers study, though not emphasized by them, is that increases in per capita income, at least in the United States, do not seem to increase happiness. U.S. per capita income, adjusted for inflation, has more than doubled since 1970, yet happiness has declined.

The reason that happiness has not increased even though per capita income has increased may be that in comparing happiness at year t and at year t + 40, one is asking the inhabitants of two very different societies (whether it is the same person asked at both times or different people). The people at year t didn’t know what conditions would be 40 years hence, and so couldn’t feel unhappy because they couldn’t experience those conditions. If happiness is relative to existing opportunities, a change in those opportunities needn’t affect it.

Happiness moreover is a psychological, which is to say a biological, state, and biological states are not as variable as income is. There are people in the world today who earn $1 a day, and people who earn $1 million a day, but it would be inconceivable than the latter was one million times happier than the former, just as no person in any society can run a million times faster than the slowest runner. The human biology may simply be such that the elasticity of happiness to income is very low.

But one should distinguish between happiness and preferences, and hence between maximizing happiness and maximizing preference satisfaction. People have a strong preference for more income over less and thus for a rising standard of living. Adam Smith argued in The Wealth of Nations that people fooled themselves in thinking they would be happier with more money. Maybe so; but as long as people do have this strong preference, economics can explain a great deal of human behavior.

Research on happiness entered the economics literature about
40 years ago, and the number of articles and books on this subject by
economists has exploded during the past 15 years. Various surveys in countries
all over the world have asked individuals to indicate how “happy” they are,
where they are usually given 4-10 possibilities, ranging from very unhappy to
very happy. Then these answers are related in various ways to income level,
age, gender, degree of health, and many other characteristics. I will
concentrate on the results by income.

The earliest studies had data only for a few mainly
developed countries. They found that richer individuals within a country were
generally happier than poorer individuals, but that average degree of happiness
was not greater in richer countries than in poorer ones. This led to various
attempted explanations, but the most common was the claim that happiness
depends on how rich a person is relative to others in the same country or
region. This was supposed to be the reason why average happiness did not appear to be higher
in richer than poorer countries since one’s peers also have higher incomes in
richer countries. Such a relative income hypothesis was not implausible, but
like many other seemingly plausible theories based on limited data, it turned
out to be wrong when happiness data became available for many
countries at very different stages of economic development.

Stevenson and Wolfers’ “Economic Growth and Subjective
Well-Being”, published in Brookings Papers, Spring 2008, is the best discussion
I have seen of happiness data for a large number of countries (I comment on
their paper in the same volume). They reproduce the result found with the early
data that high-income persons within a country are much happier on average than
poor persons. They also find, however, contrary to earlier findings, that
average degree of happiness is higher in countries with higher average per
capita incomes, and that the relation between income and happiness among
countries appears to be about as strong as the relation within countries.

Happiness in the United States does not appear to be
exceptional in these cross-country comparisons since Americans are much happier
on average than are individuals in much poorer nations. The US data show the
high average degree of happiness that is appropriate to its high average
incomes. Technically, what I mean is that the US falls about on the curve that
bests fits the relation between happiness measures and incomes –see Stevenson
and Wolfers, Figures 4 and 5. They argue, correctly I believe, that it is best,
as in these figures, to compare the relation between changes in degree of
happiness with percentage, not absolute, changes in levels of average incomes
across countries. A $1000 increase in per capita income means a lot more to
persons in poor countries than to those in rich countries.

On the whole, the data also indicate that reported average
happiness tends to rise over time within a country as per capita incomes rise,
or falls when per capita incomes fall, as in countries after the fall of
communism. One apparent exception is the United States, where reported average
happiness did not increase during the past three decades even though average
incomes did. Stevenson and Wolfers provide a number of possible reasons why this
occurred, including non-comparable data over time, and increasing income
inequality in the US during this period. Still, this result remains something
of a puzzle, given all the other evidence on the positive relation between
reported happiness and income.

The big question that is not answered by their results, or
by those of other economists who have used happiness data, is what happiness data tell us
about wellbeing. That is, about lifetime “utility” of persons who differ by
income and other characteristics? Virtually all economists who have written on
happiness automatically assume that it is a quantitative measure of utility,
and that this provides a way to make interpersonal comparisons of utility and
wellbeing. But I argue in my comment on the Stevenson-Wolfers paper that
“happiness”, even if accurately measured by these surveys, is not the same as
utility or wellbeing. Rather, happiness may be an important component of
utility that often, but not always, moves in the same direction as utility.

I use health as an analogy to happiness. Individuals
generally get more utility when they expect to live longer and are in better
health. However, they do not try to simply maximize how long they live and the
quality of their health since they may trade off lower life expectancy for
higher income by taking jobs with greater risks to their lives, or for
pleasures of food, drink, driving fast, and other activities. The same is true
for “happiness. Yes, individuals generally prefer to be happier, but sometimes
they are willing to trade off happiness for other behavior that gives them
greater utility.

This distinction helps explain why so many persons want to
immigrate, and many have immigrated, to the United States (and other richer
countries). Their lives are often very difficult for a number of years since
they usually come with little money, do not have jobs, may not know English,
encounter discrimination, and experience other obstacles and difficulties. They
may be quite unhappy for a number of years-I have not found happiness data for
immigrants- but many of them stick it out, while the unhappiest immigrants may
return to the countries they came from. The immigrants who remain do not
believe they made the wrong decision to immigrate, but anticipate that their
lives will get better, and especially that their children will have much better
opportunities in the United States than they could have had in their home
countries.

I am also doubtful that the decline since 1970 in reported happiness
of women compared to men in many countries is an indicator that the utility of
women has declined, either absolutely or relatively. Many women who work as
well as do most of the housework and childcare do not report themselves as
happy, but they reveal a preference for the higher income and status that comes
from working compared to staying home full time.

My conclusion is that happiness data have been useful, and
the relation with income is plausible. Yet happiness data do not enable us to
directly measure utility and wellbeing. I admit I do not know why average
degree of happiness has not risen in recent decades in the US as incomes rose.
Perhaps the considerations advanced by Stephenson and Wolfers explain why, or
perhaps utility has in fact not improved over time, or perhaps more likely happiness
statistics are deviating from unmeasured increases in utility.

01/04/2010

The current issue of the Economist recognizes that the
dramatic change in labor force participation of women is one of the most
important transformations in the economic and social worlds during the past
generation. I will discuss the main forces behind this change, and also
consider whether the United States needs additional public policies to
accommodate women at work.

Several crucial changes have contributed to transforming the
position of women. Perhaps the most fundamental during the past half century
were technological advances, such as the computer, and the shift in richer
countries away from manufacturing and toward services. These developments put
much greater emphasis on knowledge and information as opposed to physical
strength and heavy work, which in turn greatly increased the importance of
higher education.

Women have shown a greater capacity than men in completing
universities and four-year colleges, largely because women have greater and
less variable non-cognitive skills, such as study habits. While the fraction of
men with four-year college degrees in the United States has stagnated since
1970, the fraction of women with these degrees has exploded, so that now women
receive almost 60% of the four-year degrees in the United States compared to
only 40% in 1970. Similar shifts in higher education toward women have taken
place in European countries. Related trends are occurring also in developing
countries, even in fundamentalist Iran.

The increased importance of skills and knowledge has greatly
affected parental fertility and investment decision. As parents have recognized
the importance of a good education and other training to succeed in the modern
world, they have opted for fewer children since giving extensive education to
many children would be too expensive. Therefore, modern parents have lower
birth rates than parents did in the past, and instead invest much more in each
child. This has produced sharply declining birth rates almost everywhere, and
below replacement fertility rates in about 90 countries that include all
European nations, much of Asia, including China, Japan, and South Korea, and
even a few mainly Moslem nations.

The declines in fertility and shift toward greater
investment in children have been accelerated by the growing education of women,
who tend to be particularly concerned about providing a good education to their
children. This helps explain why educated women have relatively few children
and invest more in the schooling of each child. In addition, the time spent by
educated mothers in child rearing is more expensive since they can earn more in
the labor force. This too helps explain why women who graduate from college
have always tended to have fewer children than other women did.

These trends toward greater emphasis on knowledge and
information, low fertility, and much greater education of women, have all
contributed to the large growth in the labor force participation of women
during the past several decades. For example, about 80% of American women with
a college education are in the labor force compared to less than 50% for female
high school dropouts. Although women are more likely to work part time than
men, the gap in their labor force participation rates has greatly narrowed.

The recession affected men much harder than women since men
are more likely to work in construction and manufacturing, two sectors
especially hit hard. As a result, in recent months women have made
up about half the labor force in the United States. This fraction will fall as
the economy recovers, but the trend is still strongly toward gender equality in
labor force participation, and perhaps even toward a majority of participants
being women. This is partly because low skilled men have been withdrawing from
the labor force.

Although women still lag by a lot in their representation in
the top managerial positions, they have greatly narrowed the gap between their
full time earnings and that of men. Wives earn more than their husbands in perhaps 30% of all American families
with two earners, and that percentage
continues to grow. American women are starting new businesses at a much faster
rate than they did in the past, and the number of female heads of large
companies, although small in number, has been growing.

Although the United States has instituted various policies
to help working women, unlike Sweden and other Scandinavian countries it does
not provide extensive public subsidies to childcare, does not have a system of
legislated paid leaves to women that allow them to care for newborn children,
and does not guarantee that they can get their jobs back when they return to
work. Yet, contrary to many claims, I believe that the less interventionist
American approach may not have impeded, and may even have encouraged, women’s’
progress in the labor force.

Despite all the subsidies to childcare in Scandinavian
countries, the US still has higher fertility rates than Sweden, Norway, or
Denmark, and also than other European countries. Moreover, the labor force
participation rates of women in the US are not much below those in Scandinavian
countries, especially after considering that American birth rates are higher,
and that some women in Scandinavian countries are counted as having jobs even
when they are on paid child care leaves.

Married women in the United States with at least a high
school education can “afford” to pay for childcare, and forego employment for
months or even years after having children, since they are usually married to
husbands who have decent to high earnings. Many of these women do leave work
for a while to care for their children, even when that means they reduce their
opportunities to advance when they return to work. I do not believe there is
much of a case for the government to pay these married women to take leaves
from work when they have children, or guarantee them their jobs when they
return to work. Government policies should be rather neutral about whether
women leave work to care for children or continue to work.

On the other hand, public policies to help children of
poorer women, including children of many unmarried women, may be justified since
these women tend to under invest in their children because they have limited
incomes and often low education levels. Childcare assistance and other subsidies
to investments in the young children of these women could well have a high social
return. The US does subsidize childcare programs for low-income families, and
could increase the subsidies to various head start programs.

But such interventions would not justify the Scandinavian
approach of generously subsidizing all women, including well off women, to take
paid leaves when they have children. Despite all their job guarantees after
they return to work from childcare leaves, private sector opportunities for
Scandinavian women, and women in several other European countries, are limited.
For example, about three-quarters of employed women in Sweden work for the
government compared to one-quarter of employed men, and women comprise a much
larger fraction of senior managers of American companies than of Swedish companies.